PAPER – 4 : COST ACCOUNTING AND FINANCIAL MANAGEMENT

All questions are compulsory.

Working notes should form part of the answer.
Question 1
Answer any five of the following:
(i) What are the main objectives of cost accounting?
(ii) Discuss the treatment of over time premium in cost accounting.
(iii) Explain controllable and non-controllable cost with examples.
(iv) What are the main advantages of cost plus contract?
(v) Discuss the difference between allocation and apportionment of overhead.
(vi) Standard output in 10 hours is 240 units; actual output in 10 hours is 264 units. Wages
rate is Rs. 10 per hour. Calculate the amount of bonus and total wages under Emerson
Plan. (5  2 = 10 Marks)
Answer
(i) The Main objectives of Cost Accounting are
1. Ascertainment of cost.
2. Determination of selling price.
3. Cost control and cost reduction.
4. Ascertaining the project of each activity.
5. Assisting management in decision-making.
6. Determination of break even point.
(ii) Treatment of over time premium under Cost Accounting:
The overtime premium is treated as follows:
1. If the overtime is resorted to at the desire of the customer, then the overtime
premium may be charged to the job directly.
2. If overtime is required to cope with general production or for meeting urgent orders,
the overtime premium should be treated as overhead cost of the particular
department or cost centre which works overtime.
3. If overtime is worked in a department due to fault of another department, the
overtime premium should be charged to the latter department.
2 PROFESSIONAL COMPETENCE EXAMINATION : MAY, 2008

4. Overtime worked on account of abnormal conditions such as flood, earthquakes,

civil disturbance etc. should not be charged to cost but to costing Profit and Loss
Account.
(iii) Controllable costs are those which can be influenced by the action of a specified member
of an undertaking. A business organization is usually divided into a number of
responsibility centres and each such centre is headed by an executive. Controllable
costs incurred in a particular responsibility centre can be influenced by the action of the
executive heading that responsibility centre. Direct costs comprising direct labour, direct
materials, direct expenses and some of the overhead are generally controllable by the
shop level management.
Non-controllable costs are those which cannot be influenced by the action of a specified
member of an undertaking. For example, expenditure incurred by the tool room is
controllable by the tool room manager but the share of the tool room expense which is
apportioned to the machine shop cannot be controlled by the machine shop manager. It
is only in relation to a particular individual that a cost may be specified as controllable or
not.
Note: 1. A supervisor may be unable to control the amount of managerial remuneration
allocated to his department but for the top management this would be a
controllable cost.
2. Depreciation would be a non-controllable cost in the short-term but controllable
in the long terms.
(iv) Costs plus contracts have the following advantages:
1. The contractor is assured of a fixed percentage of profit. There is no risk of
incurring any loss on the contract.
2. It is useful especially when the work to be done is not definitely fixed at the time of
making the estimate.
3. Contractee can ensure himself about “the cost of the contract”, as he is empowered
to examine the books and document of the contractor to ascertain the veracity of
the cost of the contract.
(v) The following are the differences between allocation and apportionment.
1. Allocation costs are directly allocated to cost centre. Overhead which cannot be
directly allocated are apportioned on some suitable basis.
2. Allocation allots whole amount of cost to cost centre or cost unit where as
apportionment allots part of cost to cost centre or cost unit.
3. No basis required for allocation. Apportionment is made on the basis of area,
assets value, number of workers etc.
 PAPER – 4 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 3

264
(vi) Efficiency percentage =  100  110%
240
As per Emerson plan, in case of above 100% efficiency bonus of 20% of basic wages
plus 1% for each 1% increase in efficiency is admissible.
So, new bonus percentage = 20 + (110 – 100) = 30
30
Total Bonus = (hours worked  rate per hour)
100
30
=  10  10  Rs. 30
100
Total wages = Rs. (10  10) + 30 = Rs. 130.
Question 2
TQM Ltd. has furnished the following information for the month ending 30th June, 2007:
Master Budget Actual Variance
Units produced and sold 80,000 72,000
Sales (Rs.) 3,20,000 2,80,000 40,000 (A)
Direct material (Rs.) 80,000 73,600 6,400 (F)
Direct wages (Rs.) 1,20,000 1,04,800 15,200 (F)
Variable overheads (Rs.) 40,000 37,600 2,400 (F)
Fixed overhead (Rs.) 40,000 39,200 800 (F)
Total Cost 2,80,000 2,55,200

The Standard costs of the products are as follows:

Per unit
(Rs.)
Direct materials (1 kg. at the rate of Re. 1 per kg.) 1.00
Direct wages (1 hour at the rate of Rs. 1.50) 1.50
Variable overheads (1 hour at the rate of Re. .50) 0.50
Actual results for the month showed that 78,400 kg. of material were used and 70,400 labour
hours were recorded.
Required:
(i) Prepare Flexible budget for the month and compare with actual results.
(ii) Calculate material, labour, sales price, variable overhead and fixed overhead expenditure
variances and sales volume (profit) variance. (5 + 10 = 15 Marks)
4 PROFESSIONAL COMPETENCE EXAMINATION : MAY, 2008

Answer
(i) Statement showing flexible budget and its comparison with actual
Master Flexible budget (at Actual for Variance
budget standard cost) 72,000
(80,000 units
units)
Per unit 72,000
units
A. Sales 3,20,000 4.00 2,88,000 2,80,000 8,000 (A)
B. Direct material 80,000 1.00 72,000 73,600 1,600 (A)
C. Direct wages 1,20,000 1.50 1,08,000 1,04,800 3,200 (F)
D. Variable overhead 40,000 0.50 36,000 37,600 1,600 (A)
E. Total variable cost 2,40,000 3.00 2,16,000 2,16,000 
F. Contribution 80,000 1.00 72,000 64,000 
G. Fixed overhead 40,000 0.50 40,000 39,200 800 (F)
H. Net profit 40,000 0.50 32,000 24,800 7,200 (A)

(ii) Variances:
 Sales price variance = Actual Quantity (Standard Rate – Actual Rate)
= 72,000 (4.00 – 3.89) = 8,000 (A)
 Direct Material Cost Variance = Standard Cost for actual output – Actual cost
= 72,000 – 73,600 = 1,600 (A)
 Direct Material Price Variance = Actual Quantity (Standard rate – Actual Rate)
 73,600  
= 78,400  1.00      4,800 (F)
  78,400  
 Direct Material Usage Variance = Standard Rate (Standard Quantity – Actual
Quantity)
= 1.0 (72,000 – 78,400) = 6,400 (A)
 Direct Labour Cost Variance = Standard Cost for actual output – Actual cost
= 1,08,000 – 1,04,800 = 3,200 (F)
 Direct Labour Rate Variance = Actual Hour (Standard Rate – Actual Rate)
 1,04,800  
= 70,400  1.5      800 (F)
  70,400  
 PAPER – 4 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 5

 Direct Labour Efficiency = Standard Rate (Standard Hour – Actual Hour)

Variance = 1.5 (72,000 – 70,400) = 2,400 (F)
 Variable Overhead = Recovered variable overhead – Actual variable
overhead
= (72,000  0.50) – 37,600 = 1,600 (A)
 Fixed Overhead Expenditure = Budgeted fixed overhead – Actual fixed
Variance overhead
= 40,000 – 39,200 = 800 (F)
 Sales Volume (Profit) Variance = Standard rate of profit
(Budgeted Quantity – Actual Quantity)
= .50 [80,000 – 72,000] = 4,000 (A)
Question 3
(a) JK Ltd. produces a product “AZE”, which passes through two processes, viz., process I
and process II. The output of each process is treated as the raw material of the next
process to which it is transferred and output of the second process is transferred to
finished stock. The following data related to December, 2007:
Process I Process II
25,000 units introduced at a cost of Rs. 2,00,000 
Material consumed Rs. 1,92,000 96,020
Direct labour Rs. 2,24,000 1,28,000
Manufacturing expenses Rs. 1,40,000 60,000
Normal wastage of input 10% 10%
Scrap value of normal wastage (per unit) Rs. 9.90 8.60
Output in Units 22,000 20,000
Required:
(i) Prepare Process I and Process II account.
(ii) Prepare Abnormal effective/wastage account as the case may be each process.
(b) ZED Company supplies plastic crockery to fast food restaurants in metropolitan city. One
of its products is a special bowl, disposable after initial use, for serving soups to its
customers. Bowls are sold in pack 10 pieces at a price of Rs. 50 per pack.
The demand for plastic bowl has been forecasted at a fairly steady rate of 40,000 packs
every year. The company purchases the bowl direct from manufacturer at Rs. 40 per
pack within a three days lead time. The ordering and related cost is Rs. 8 per order. The
storage cost is 10% per cent per annum of average inventory investment.
6 PROFESSIONAL COMPETENCE EXAMINATION : MAY, 2008

Required:
(i) Calculate Economic Order Quantity.
(ii) Calculate number of orders needed every year.
(iii) Calculate the total cost of ordering and storage bowls for the year.
(iv) Determine when should the next order to be placed. (Assuming that the company
does maintain a safety stock and that the present inventory level is 333 packs with a
year of 360 working days. (8 + 8 = 16 Marks)
Answer
(a) Process I Account
Particulars Units Amount Particulars Units Amount
(in Rs.) (in Rs.)
To Input 25,000 2,00,000 By Normal wastage 2,500 24,750
To Material 1,92,000 By Abnormal wastage 500 16,250
To Direct Labour 2,24,000 By Process II 22,000 7,15,000
To Manufacturing Exp. _____ 1,40,000 _____ _______
25,000 7,56,000 25,000 7,56,000

7,56,000  24,750
Cost per unit   Rs. 32.50 per unit
25,000  2,500
Process II Account
Particulars Units Amount Particulars Units Amount
(in Rs.) (in Rs.)
To Process I 22,000 7,15,000 By Normal wastage 2,200 18,920
To Material 96,020 By Finished stock 20,000 9,90,000
To Direct Labour 1,28,000
To Manufacturing Exp. 60,000
To Abnormal effect 200 9,900 _____ _______
22,200 10,08,920 22,200 10,08,920

9,99,020  18,920
Cost per unit   Rs. 49.50 per unit
22,000  2,200
 PAPER – 4 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 7

Abnormal Wastage Account

Particulars Units Amount Particulars Units Amount
(in Rs.) (in Rs.)
To Process I A/c 500 16,250 By Cash (Sales) 500 4,950
By Costing Profit and
___ _____ Loss A/c ___ 11,300
500 16,250 500 16,250

Abnormal Effectives Account

Particulars Unit Amount Particulars Units Amount
(in Rs.) (in Rs.)
To Normal wastage 200 1,720 By Process II
A/c 200 9,900
To Costing Profit and Loss ___ 8,180 ___ ____
200 9,900 200 9,900

(b) (i) Economic Order Quantity

2CO
EOQ 
UI
2  40,000  8

4
 1,60,000 = 400 packs.
(ii) Number of orders per year
Annual requirements
Economic order quantity
40,000
 100 order per year
400
(iii) Ordering and storage costs
Rs.
Ordering costs :– 100 orders  Rs. 8.00 800
Storage cost :– (400/2)  (10% of 40) 800
Total cost of ordering & storage 1,600
(iv) Timing of next order
(a) Day’s requirement served by each order.
8 PROFESSIONAL COMPETENCE EXAMINATION : MAY, 2008

No. of working days

Number of days requirements 
No. of order in a year
360
  3.6 days supply
100
This implies that each order of 400 packs supplies for requirements of 3.6 days
only.
(b) Days requirement covered by inventory
Units in inventory
  (Day requirement served by an order)
Economic order quantity
333
  3.6 days  3 days requirement
400
(c) Time interval for placing next order
Inventory left for day’s requirement – Lead time of delivery
3 day’s requirements – 3 days lead time = 0
This means that next order for the replenishment of supplies has to be placed
immediately.
Question 4
Answer any three of the following:
(i) Explain and illustrate cash break-even chart.
(ii) Discuss ABC analysis as a technique of inventory control.
(iii) Distinguish between Job evaluation and Merit rating.
(iv) A company has fixed cost of Rs. 90,000, Sales Rs. 3,00,000 and Profit of Rs. 60,000.
Required:
(i) Sales volume if in the next period, the company suffered a loss of Rs. 30,000.
(ii) What is the margin of safety for a profit of Rs. 90,000? (3  3 = 9 Marks)
Answer
(i) In cash break-even chart, only cash fixed costs are considered. Non-cash items like
depreciation etc. are excluded from the fixed cost for computation of break-even point. It
depicts the level of output or sales at which the sales revenue will equal to total cash
outflow. It is computed as under:
Cash Fixed Cost
Cash BEP (Units) 
Cost per Units
 PAPER – 4 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 9

Hence for example suppose insurance has been paid on 1st January, 2006 till 31st
December, 2010 then this fixed cost will not be considered as a cash fixed cost for the
period 1st January, 2008 to 31st December, 2009.
(ii) ABC Analysis as a technique of Inventory Control:
It is a system of inventory control. It exercises discriminating control over different items
of stores classified on the basis of investment involved. Usually they are divided into
three categories according to their importance, namely, their value and frequency of
replenishment during a period.
‘A’ category of items consists of only a small percentage i.e. about 10% of total items
handles by the stores but require heavy investment about 70% of inventory value,
because of their high price or heavy requirement or both.
‘B’ category of items are relatively less important – 20% of the total items of material
handled by stores and % of investment required is about 20% of total investment in
inventories.
‘C’ category – 70% of total items handled and 10% of value.
For ‘A’ category items, stocks levels and EOQ are used and effective monitoring is done.
For ‘B’ category same tools as in ‘A’ category are applied.
For ‘C’ category of items, there is no need of exercising constant control. Orders for
items in this group may be placed after 6 months or once in a year, after ascertaining
consumption requirement.
(iii) Job Evaluation and Merit Rating:
 Job evaluation is the assessment of the relative worth of jobs within a company and
merits rating are the assessment of the relative worth of the man behind the job.
10 PROFESSIONAL COMPETENCE EXAMINATION : MAY, 2008

 Job evaluation and its accomplishment are means to set up a rational wage and
salary structure where as merits rating provides a scientific basis for determining
fair wages for each worker based on his ability and performance.
 Job evaluation simplifies wage administration by bringing an uniformity in wage
rates where as merits rating is used to determine fair rate of pay for different
workers.
Contribution
(iv) P/V ratio   100
Sales
 1,50,000 
  100   50%
 3,00,000 
(i) If in the next period company suffered a loss of Rs. 30,000, then
Contribution = Fixed Cost  Profit
= Rs. 90,000 – Rs. 30,000 (as it is a loss)
= Rs. 60,000.
Contribution 60,000
Then Sales = or  Rs. 1,20,000.
P/V ratio .50
So, there will be loss of Rs. 30,000 at sales of Rs. 1,20,000.
Profit 90,000
(ii) Margin of safety  or  Rs. 1,80,000.
PV ratio .50
Alternative solution of this part:
Fixed Cost 90,000
Break-even Sales =  = Rs. 1,80,000
PV Ratio .5
Fixed Cost  Profit
Sales at profit of Rs. 90,000 =
PV Ratio
90,000  90,000
=
.5
1,80,000
=
.5
= Rs. 3,60,000.
Margin of Safety = Sales – Break-even Sales
= 3,60,000 – 1,80,000
= Rs. 1,80,000.
 PAPER – 4 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 11

Question 5
Answer any five of the following:
(i) Explain the relevance of time value of money in financial decisions.
(ii) Discuss the features of Secured Premium Notes (SPNs).
(iii) The following data relate to RT Ltd:
Rs.
Earning before interest and tax (EBIT) 10,00,000
Fixed cost 20,00,000
Earning Before Tax (EBT) 8,00,000
Required: Calculate combined leverage
(iv) Explain the concept of closed and open ended lease.
(v) Discuss the advantages of preference share capital as an instrument of raising funds.
(vi) Explain the principles of “Trading on equity”. (5  2 = 10 Marks)
Answer
(i) Time value of money means that worth of a rupee received today is different from the
worth of a rupee to be received in future. The preference of money now as compared to
future money is known as time preference for money.
A rupee today is more valuable than rupee after a year due to several reasons:
 Risk  there is uncertainty about the receipt of money in future.
 Preference for present consumption  Most of the persons and companies in
general, prefer current consumption over future consumption.
 Inflation  In an inflationary period a rupee today represents a greater real
purchasing power than a rupee a year hence.
 Investment opportunities  Most of the persons and companies have a preference
for present money because of availabilities of opportunities of investment for
earning additional cash flow.
Many financial problem involve cash flow accruing at different points of time for
evaluating such cash flow an explicit consideration of time value of money is required.
(ii) Secured premium notes is issued along with detachable warrant and is redeemable after
a notified period of say 4 to 7 years. This is a kind of NCD attached with warrant. It was
first introduced by Tisco, which issued the SPNs to existing shareholders on right basis.
Subsequently the SPNs will be repaid in some number of equal instalments. The warrant
12 PROFESSIONAL COMPETENCE EXAMINATION : MAY, 2008

attached to SPNs gives the holder the right to apply for and get allotment of equity
shares as per the conditions within the time period notified by the company.
(iii) Contribution:
C = S – V and
EBIT =C–F
10,00,000 = C – 20,00,000
C = 30,00,000
Operating leverage = C / EBIT = 30,00,000/10,00,000 = 3 times
Financial leverage = EBIT/EBT = 10,00,000/8,00,000 = 1.25 times
Combined leverage = OL x FL = 3 x 1.25 = 3.75 times
(iv) In the close-ended lease, the assets gets transferred to the lessor at the end of lease,
the risk of obsolescence, residual values etc. remain with the lessor being the legal
owner of the assets. In the open-ended lease, the lessee has the option of purchasing
the assets at the end of lease period.
(v) Advantages of Issue of Preference Shares are:
(i) No dilution in EPS on enlarged capital base.
(ii) There is no risk of takeover as the preference shareholders do not have voting
rights.
(iii) There is leveraging advantage as it bears a fixed charge.
(iv) The preference dividends are fixed and pre-decided. Preference shareholders do
not participate in surplus profit as the ordinary shareholders
(v) Preference capital can be redeemed after a specified period.
(vi) The term trading on equity means debts are contracted and loans are raised mainly on
the basis of equity capital. Those who provide debt have a limited share in the firm’s
earning and hence want to be protected in terms of earnings and values represented by
equity capital. Since fixed charges do not vary with firms earning before interest and tax,
a magnified effect is produced on earning per share. Whether the leverage is favourable,
in the sense, increase in earning per share more proportionately to the increased earning
before interest and tax, depends on the profitability of investment proposal. If the rate of
returns on investment exceeds their explicit cost, financial leverage is said to be positive.
 PAPER – 4 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 13

Question 6
The financial statement and operating results of PQR revealed the following position as on
31st March, 2006:
— Equity share capital (Rs. 10 fully paid share) Rs. 20,00,000
— Working capital Rs. 6,00,000
— Bank overdraft Rs. 1,00,000
— Current ratio 2.5 : 1
— Liquidity ratio 1.5 : 1
— Proprietary ratio (Net fixed assets/Proprietary fund) .75 : 1
— Cost of sales Rs. 14,40,000
— Debtors velocity 2 months
— Stock turnover based on cost of sales 4 times
— Gross profit ratio 20% of sales
— Net profit ratio 15% of sales
Closing stock was 25% higher than the opening stock. There were also free reserves brought
forward from earlier years. Current assets include stock, debtors and cash only. The current
liabilities expect bank overdraft treated as creditors.
Expenses include depreciation of Rs. 90,000.
The following information was collected from the records for the year ended 31 st March, 2007:
— Total sales for the year were 20% higher as compared to previous year.
— Balances as on 31st March, 2007 were : Stock Rs. 5,20,000, Creditors Rs. 4,15,000,
Debtors Rs. 4,95,000 and Cash balance Rs. 3,10,000.
— Percentage of Gross profit on turnover has gone up from 20% to 25% and ratio of
net profit to sales from 15% to 16%.
— A portions of Fixed assets was very old (book values Rs. 1,80,000) disposed for
Rs. 90,000. (No depreciations to be provided on this item).
— Long-term investments were purchased for Rs. 2,96,600.
— Bank overdraft fully discharged.
— Percentage of depreciation to Fixed assets to be provided at the rate in the
previous year.
Required:
(i) Prepare Balance Sheet as on 31 st March, 2006 and 31 st March, 2007.
(ii) Prepare the fund flow statement for the year ended 31 st March, 2007. (15 Marks)
14 PROFESSIONAL COMPETENCE EXAMINATION : MAY, 2008

Answer Balance Sheet

Rs. Rs.
Liabilities 31 March 31 March Assets 31 March 31 March
2006 2007 2006 2007
Equity share capital 20,00,000 20,00,000 Fixed Assets
(Rs. 10 each fully (Rs.18,90,000– Rs.90,000) 18,00,000 15,39,000
paid)
Reserve and 1,30,000 1,30,000 Long term investment  2,96,600
Surplus (balancing)
Profit & Loss A/c 2,70,000 6,15,600 Current Assets
(15% of sales) (Rs. 10,00,000)
Current Liabilities Stock 4,00,000 5,20,000
Bank Overdraft 1,00,000  Sundry Debtors 3,00,000 4,95,000
Creditors 3,00,000 4,15,000 Cash at Bank (Balancing) 3,00,000 3,10,000
Total 28,00,000 31,60,600 Total 28,00,000 31,60,600

Calculation for 31 March, 2006

(i) Calculation of Current Liabilities
Suppose that Current Liabilities = x, then current assets will be 2.5 x
Working capital = Current Assets – Current Liabilities
6,00,000 = 2.5x – x
x = 6,00,000 / 1.5 = Rs. 4,00,000 (C.L.)
Other Current Liabilities = Current Liabilities – Bank Overdraft
(Creditors) 4,00,000 – 1,00,000 = Rs. 3,00,000
Current Assets = 2.5 x 4,00,000 = Rs. 10,00,000
(ii) Liquid Ratio = Liquid Assets / Current Liabilities or 1.5 = Liquid Assets / 4,00,000
= Rs.6,00,000
Liquid assets = Current Assets – Stock
6,00,000 = 10,00,000 – Stock
So, Stock = Rs. 4,00,000
(iii) Calculation of fixed assets: Fixed assets to proprietary fund is 0.75, working capital is
therefore 0.25 of proprietary fund. So,
6,00,000 / 0.25 x 0.75 = Rs. 18,00,000
 PAPER – 4 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 15

(iv) Debtors = 2 /  12 Sales

2 / 12  18,00,000 = Rs. 3,00,000
(v) Sales = (14,40,000 / 80)  100 = Rs. 18,00,000
(vi) Net profit = 15% of Rs.18,00,000 = Rs. 2,70,000
Calculation for the year 31 st March, 2007
(vii) Sales = 18,00,000 + (18,00,000  0.2) = 21,60,000
(viii) Calculation of fixed assets
Rs. Rs.
To Opening balance 18,00,000 By Banks (Sale) 90,000
By Loss on sales of Fixed asset 90,000
By P & L (Dep) (5% as in
previous year) 81,000
________ By Balance b/d 15,39,000
Total 18,00,000 18,00,000

(ix) Net profit for the year 2007, 16%  21,60,000 = Rs. 3,45,600
Total Profit = 2,70,000 + 3,45,600 = Rs. 6,15,600
Calculation of fund from operation:
Net profit for the year 2007 = Rs. 3,45,600
Add: Depreciation Rs. 81,000
Loss on sale of assets Rs. 90,000 = Rs. 1,71,000
Total = Rs. 5,16,600
Fund Flow Statement

Rs. Rs.
Fund from operation 5,16,600 Increase in WC 3,10,000
Sales of fixed assets 90,000 Pur. of investment 2,96,600
6,06,600 6,06,600
16 PROFESSIONAL COMPETENCE EXAMINATION : MAY, 2008

Schedule of changing working capital

31 March 31 March Increase Decrease
2006 2007 (+) ( )
A. Current Assets Rs. Rs. Rs. Rs.
Stock 4,00,000 5,20,000 1,20,000
Sundry debtors 3,00,000 4,95,000 1,95,000
Cash at bank 3,00,000 3,10,000 10,000
10,00,000 13,25,000
B. Current Liabilities
Bank overdraft 1,00,000  1,00,000
Sundry creditors 3,00,000 4,15,000 1,15,000
4,00,000 4,15,000
Working capital 6,00,000 9,10,000 
Increase in working capital 3,10,000 3,10,000
9,10,000 9,10,000 4,25,000 4,25,000
Question 7
(a) ABC Ltd. wishes to raise additional finance of Rs. 20 lakhs for meeting its investment
plans. The company has Rs.4,00,000 in the form of retained earnings available for
investment purposes. The following are the further details:
 Debt equity ratio 25 : 75.
 Cost of debt at the rate of 10 percent (before tax) upto Rs. 2,00,000 and 13%
(before tax) beyond that.
 Earning per share, Rs. 12.
 Dividend payout 50% of earnings.
 Expected growth rate in dividend 10%.
 Current market price per share, Rs.60.
 Company’s tax rate is 30% and shareholder’s personal tax rate is 20%.
Required:
(i) Calculate the post tax average cost of additional debt.
(ii) Calculate the cost of retained earnings and cost of equity.
(iii) Calculate the overall weighted average (after tax) cost of additional finance.
(8 Marks)
(b) C Ltd. is considering investing in a project. The expected original investment in the
project will be Rs. 2,00,000, the life of project will be 5 year with no salvage value. The
 PAPER – 4 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 17

expected net cash inflows after depreciation but before tax during the life of the project
will be as following:
Year 1 2 3 4 5
Rs. 85,000 1,00,000 80,000 80,000 40,000
The project will be depreciated at the rate of 20% on original cost. The company is
subjected to 30% tax rate.
Required:
(i) Calculate pay back period and average rate of return (ARR)
(ii) Calculate net present value and net present value index, if cost of capital is 10%.
(iii) Calculate internal rate of return.
Note:The P.V. factors are:
Year P.V. at 10% P.V. at 37% P.V. at 38% P.V. at 40%
1 .909 .730 .725 .714
2 .826 .533 .525 .510
3 .751 .389 .381 .364
4 .683 .284 .276 .260
5 .621 .207 .200 .186
(8 Marks)
Answer
(a) Pattern of raising capital = 0.25  20,00,000
Debt = 5,00,000
Equity = 15,00,000
Equity fund (Rs. 15,00,000)
Retained earning = Rs. 4,00,000
Equity (additional) = Rs. 11,00,000
Total = Rs. 15,00,000
Debt fund (Rs. 5,00,000)
10% debt = Rs. 2,00,000
13% debt = Rs. 3,00,000
Total = Rs. 5,00,000
(i) Kd = Total Interest (1  t) / Rs. 5,00,000
= [20,000 + 39,000] (1  0.3)/ 5,00,000 or (41,300 / 5,00,000)  100 = 8.26%
18 PROFESSIONAL COMPETENCE EXAMINATION : MAY, 2008

(ii) Ke = EPS  payout / mp + g = 12 (50%) / 60  100 + 10%

10% + 10% = 20%
Kr = Ke (1 – tp) = 20(1  0.2) = 16%
(iii) Weighted average cost of capital
Amount After tax Cost
Equity Capital 11,00,000 20.00% 2,20,000
Retained earning 4,00,000 16.00% 64,000
Debt 5,00,000 8.26% 41,300
Total 20,00,000 3,25,300
Ko = (3,25,300 / 20,00,000)  100 = 16.27%
(b) Project Outflow Rs. 2,00,000
Year 1 2 3 4 5
Rs. Rs. Rs. Rs. Rs.
Profit after
depreciation but
85,000 1,00,000 80,000 80,000 40,000
before tax
Tax (30 %) 25,500 30,000 24,000 24,000 12,000
PAT 59,500 70,000 56,000 56,000 28,000 Average = Rs.53,900
Add: Dep 40,000 40,000 40,000 40,000 40,000
Net cash inflow 99,500 1,10,000 96,000 96,000 68,000 Average = Rs.93,900.

Average = Rs.93,900
(i) Calculation of pay back period 1.91 years
(ii) Calculation of ARR
Initial 2,00,000 1,60,000 1,20,000 80,000 40,000
investment
Depreciation 40,000 40,000 40,000 40,000 40,000
Closing 1,60,000 1,20,000 80,000 40,000 0
investment
Average 1,80,000 1,40,000 1,00,000 60,000 20,000 Average=1,00,000
investment
ARR = Average of profit after tax / Average investment = 53.90%
(iii) Calculation of net present Value 10%
Net cash
inflow 99,500.00 1,10,000.00 96,000.00 96,000.00 68,000.00
0.909 0.826 0.751 0.683 0.621
Present
value 90,445.50 90,860.00 72,096.00 65,568.00 42,228.00 3,61,197.50
 PAPER – 4 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 19

Net present value = Rs. 3,61,197.50 – Rs. 2,00,000 = Rs. 1,61,197.50

Net present value index = Rs. 1,61,197.50 / Rs. 2,00,000 = 0.81
(iv) Calculation of IRR
Present value factor-Initial investment / Average annual cash inflow
2,00,000 / 93,900 = 2.13
It lies in between 38 % and 40%
Net Cash Inflows 99,500.00 1,10,000.00 96,000.00 96,000.00 68,000.00

Present Value
0.725 0.525 0.381 0.276 0.200
Factor @ 38%

Present value @
72,137.50 57,750.00 36,576.00 26,496.00 13,600.00 Total = 2,06,559.50
38% (P1)

Net Cash Inflows 99,500.00 1,10,000.00 96,000.00 96,000.00 68,000.00

Present Value
0.714 0.510 0.364 0.260 0.186
Factor @ 40%

Present value @
71,043 56,100 34,944 24,960 12,648 Total = 1,99,695
40% (P2)

IRR is calculated by Interpolation:

IRR = LDR + (P1  Q) / P1  P2 (SDR  LDR)
= 38 + (2,06,559.50  2,00,000) / (2,06,559.50  1,99,695)  (40  38)
= 39.911137%
Question 8
Answer any three of the following:
(i) Explain the concept of Debt securitization.
(ii) Explain briefly the functions of Treasury Department.
(iii) Explain briefly the features of External Commercial Borrowings. (ECB)
(iv) The Sales Manager of AB Limited suggests that if credit period is given for 1.5 months
then sales may likely to increase by Rs. 1,20,000 per annum. Cost of sales amounted to
90% of sales. The risk of non-payment is 5%. Income tax rate is 30%. The expected
return on investment is Rs. 3,375 (after tax). Should the company accept the suggestion
of Sales Manager? (3  3 = 9 Marks)
20 PROFESSIONAL COMPETENCE EXAMINATION : MAY, 2008

Answer
(i) Debt securitization is a method of recycling of funds. It is especially beneficial to financial
intermediaries to support the lending volumes. Assets generating steady cash flows are
packaged together and against this assets pool, market securities can be issued. The
debt securitization process can be classified in the following three functions.
1. The origination function: The credit worthiness of a borrower seeking loan from a
finance company, bank, housing company or a leasing company is evaluated and a
contract is entered into and repayment schedule is structured over the life of the
loan.
2. The pooling function: Similar loans or receivables are clubbed together to create an
underlying pool of assets. This pool is transferred in favour of a special purpose
vehicle (SPV).
3. The securitization function: After structuring, issue the securities on the basis of
asset pool. The securities carry a coupon and an expected maturity, which can be
asset based or mortgaged based. These are generally sold to investors through
merchant bankers.
The process of securitization is generally without recourse i.e. the investor bears credit
risk or risk of default and the user is under an obligation to pay to investor only if the
cash flow are received by him from the collateral.
(ii) The functions of treasury department management is to ensure proper usage, storage
and risk management of liquid funds so as to ensure that the organisation is able to meet
its obligations, collect its receivables and also maximize the return on its investments.
Towards this end the treasury function may be divided into the following:
(i) Cash Management: The efficient collection and payment of cash both inside the
organization and to third parties is the functions of treasury department. Treasury
will normally manage surplus funds in an investment portfolio.
(ii) Currency Management: The Treasury Department manages the foreign currency
risk exposer of the company.
(iii) Funding Management: The Treasury Department is responsible for planning and
sourcing the company short, medium and long term cash needs.
(iv) Banking: Company maintains good relationship with its bankers. The Treasury
Department carry out negotiations with bankers and act as the initial points of
contact with them.
(v) Corporate Finance: The Treasury department is involved with both acquisition and
disinvestment activities with in the group.
 PAPER – 4 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 21

(iii) An ECB is a loan taken from non-resident lenders in accordance with exchange control
regulations. These loans can be taken from:
 International banks
 Capital markets
 Multilateral financial institutions like IFC, ADB, IBRD etc.
 Export Credit Agencies
 Foreign collaborators
 Foreign Equity Holders.
ECB can be accessed under automatic and approval routes depending upon the purpose
and volume.
In automatic there is no need for any approval from RBI / Government while approval is
required for areas such as textiles and steel sectors restructuring packages.
(iv) Profitability on additional sales:
Rs.
Increase in sales 1,20,000
Less: Cost of sales (90% sales) 1,08,000
Less: Bad debt losses (5% of sales) 6,000
Net profit before tax 6,000
Less: Income tax (30%) 1,800
4,200

Net profit after tax Rs. 4,200 on additional sales is higher than expected return. Hence,
proposal should be accepted.